If you’re seeing higher prices at the pump, the grocery store and power bills, you’re not alone.  The Consumer Price Index rose 6.8 percent from November 2020 November 2021, the largest 12-month increase since the period ending June 1982. Energy prices rose a whopping 33.3 percent over the last year, and food prices increased 6.1 percent.

Inflation is a general price increase of goods and services gradually over time. Inflation can occur when prices rise due to increases in production costs, such as raw materials and wages. A surge in demand for products and services can cause inflation as consumers are willing to pay more for the product. This temporarily increases the relative cost of living.  The cost of goods and services increasing affects every household and also financial markets.  Inflation represents a major intersection of Main Street and Wall Street.  The majority of prognosticator’s inflation predictions have been proven drastically incorrect, with prices going higher and staying there longer than most ever anticipated and the predictions for 2022 appear even more uncertain. 

During the Covid-19 pandemic, most businesses needed to reduce their services and orders for goods — on, say, semiconductor chips used for cars or waiting staff for their restaurant — and that led to some supply shortfalls that still linger today.

Now, as the United States – and the world – is opening back up and people are starting to spend money again, the US demand for goods is skyrocketing: Inflation-adjusted retail spending is up 14 percent over the past two years. This is great news. With the improvement in the roll-out of vaccines, the US economy is starting to grow very quickly. In the second quarter of 2021, real GDP increased 6.7 percent.

Energy prices are a key part of headline consumer price inflation (CPI) numbers and have been one of the primary culprits and have broadly increased in late 2021. The price of West Texas Intermediate crude oil, the U.S. benchmark for energy, more than doubled in the 12 months ended October 31, 2021. U.S. natural gas prices also have more than doubled in the year ended in October.

The Biden administration’s strategy has been to release oil reserves to decrease gas prices vs. increase our oil production. The whole world is short on energy, and bad actors like Putin know it. Over the last few months, Putin has been accused of withholding gas in order to drive up prices and hurt the US economy. Decreasing gas prices has a rippling effect on the prices of most goods. Cheaper transportation results in cheaper goods.

For the U.S. our domestic energy production, measured by oil rig counts, has been slow to rebound following the price crash at the beginning of the pandemic in March 2020.   U.S. crude output fell as demand dropped during the COVID-19 pandemic, and has not yet returned to pre-pandemic record production of 12.966 million bpd, seen in November, 2019.  Crude output will drop 260,000 barrels per day to 11.02 million bpd this year, and then rebound to 11.73 million bpd in 2022, the U.S. Energy Information Administration said.

Supply Chain Issues – Fewer Toys For Tots?

Another culprit of demand outstripping supply is the well‑publicized supply chain problems and labor shortages affecting industries from toys made in China to automobiles manufactured in the U.S. or the eurozone have contributed to unheard‑of price increases in some segments, such as used cars. These supply chain and labor market problems have already dragged on for longer than many had originally predicted. The market consensus in early November was that the peak of the supply chain disruptions had already occurred, meaning that the problems had stopped worsening.

However, many believe the data suggesting that supply chain issues have stopped getting worse are a from the third‑quarter growth slowdown from the spread of the delta variant, not actual improvement in supply problems. Supplier delivery times, used car prices, gasoline and food prices, and refrigerated trucking rates have all ticked up as the delta wave has diminished. This could indicate that the supply chain problems may still worsen, supporting inflation well into the first half of 2022.

Housing Prices Continue Their Climb

Shelter costs, which are a part of services inflation and include rent and a calculated cost of living in one’s own home (called owners’ equivalent rent), make up about one‑third of CPI. Rents softened in 2020 as people shifted to working from home, allowing them to move out of high‑density, high‑rent urban areas. Housing prices rose as demand for more living space and a lack of new housing supply. Mortgage rates fell to record lows as Treasury yields dropped at the onset of the pandemic, further raising housing demand and home prices.

The government’s 2020 moratorium on renter evictions has ended, which could trigger more renter turnover and allow landlords to raise rent. The most meaningful rent increases tend to occur with new leases, and we anticipate that returning demand for urban apartments will push rents higher. As a result, some are predicting shelter prices to increase about 5% on the year‑earlier period over the next six months.

Inflation’s Impact On Portfolios

The latest numbers showed that inflation at 6.8%, meanwhile the ten- year Government Treasury Bill at this time only yields 1.48%.  Since interest rates are expected to remain lower for some time, the implication for investors is that if we want to keep our money growing ahead of inflation, we may have to re-align portfolio allocation to include some higher amount of growth assets, since fixed income investments like bonds and CDs are not going to generate enough yield to offset the impacts of inflation.  Let’s remember that there are many categories of risk.  Most think of market risk in the stock market but there is also inflation risk- the loss of purchasing power over time and interest rate risk- where rising rates cause bond prices to decline.  Jeremy Siegal, a veteran market strategist with the Wharton School of Business has done extensive research on the topic of sustainable retirement income and has major concerns that the old standard 60/40 stock to bond allocation runs the risk of not producing sufficient income for a retiree’s lifetime and avoid the risk of running out of money before running out of time.   So, we’re having conversations with our clients about these important issues going forward. 

Any opinions are those of Thomas Fleishel and not necessarily those of Raymond James. Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. Every investor’s situation is unique and you should consider your investment goals, risk tolerance and time horizon before making any investment. Prior to making an investment decision, please consult with your financial advisor about your individual situation.